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Friday, May 9, 2008

Using Parametric Cost Modeling

Certain industries have been around long enough that project managers who work in those industries have developed standardized mathematical formulas for estimating project costs. The use of mathematical formulas in cost estimating is called parametric modeling.

For most projects, the main parameters, or characteristics, that affect costs are time and materials. A good example of a parametric model is the cost of residential home construction. Builders often base cost estimates for a house on so many dollars per square foot of living space. Examples of simple and complex parametric models are provided below.

Simple. The costs to build a road are based on a standard cost per mile. The cost to blast through bedrock is based on the volume of rock to be removed.

Complex. A model for estimating software development may incorporate several adjustment factors for each function within an application.

Some parametric models are meant to give a rough estimate of costs, while others are designed to provide more accurate estimates. You can use parametric modeling when the following three criteria are in place.

1. Your project has quantifiable parameters.
Since a parametric model is a mathematical formula, the variables or parameters of a project that you use must be readily quantifiable. This means that the component or components upon which you base costs must have a unit of measurement, such as weight, length, number, or grade.

Most types of projects contain quantifiable variables. For example, a training company could estimate costs to be so many dollars per hour of instruction, or a food manufacturer could estimate so many dollars per pound of finished product.

2. The parametric model is scalable.
To be reliable, a parametric model must also be scalable, meaning that it must apply to a large project as well as it does to a small one. Most projects, even those of a similar nature, vary in terms of product scope, so you need a model that allows for a range in the number or size of products delivered.

Some models, though perfectly scalable, may have upper and lower limits that invalidate the model if project scope exceeds the limits. For example, economies of scale may come into effect for a large project, reducing costs proportionately. For other models or types of projects, larger scale means extra work, thereby increasing costs.

3. Accurate historical information has been used to develop an appropriate model.
The third main criteria for determining whether using a parametric model is appropriate for your project is whether there is an existing model, or the potential to build one, based on historical information. The accuracy of your estimates increases with the accuracy of the data used in the model.

Many companies develop their own parametric models specific to the types of projects they perform. All you need is enough data from previous projects to establish the mean costs of products or services provided in the past.

Many industries have used historical information to develop parametric models in the form of software applications. The time that the software saves you in estimating costs quickly, and the accuracy it provides, are worth the cost.

In summary, you can use parametric modeling when your project has quantifiable characteristics and there is sufficient accurate historical data to develop a scalable and dependable mathematical formula for estimating costs.

1 comment:

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